What is a Cross Option Agreement?
A Cross Option Agreement (COA) is a legal document whereby both partners are given an option to buy or sell their respective shares when one of them dies. This means that the surviving partner has the option to buy the shares of the deceased partner. The COA also gives the executors of the deceased partner the option and power to sell those shares.
Why have a Cross Option Agreement?
COAs are useful where a small business is set up and run through the medium of a limited company and is owned by the two founders of the business (who become directors and shareholders in the company), and one of the parties dies. As a result, the following undesirable outcomes can occur if there is no COA in place:
1.Â Â The surviving party may wish to purchase the shares of the deceased party but the executors of the deceased party may not wish to sell them.
2.Â Â The widow(er) of the deceased party may wish to have involvement in the running of the business which the surviving party may not be happy with.
3.Â Â The executors of the deceased party may wish to sell the shares but the surviving party could be in a position where it does not wish to buy them or may not have the funds to purchase them. In the latter case, the shares may be sold elsewhere, which is likely to be undesirable to the surviving party.
4.Â Â Where the parties enter into a partnership agreement and agree that the surviving party can buy the shares of the deceased party, then this will be considered a binding agreement between the parties entered into before death. As such, it will result in the loss of Business Relief for Inheritance Tax purposes (Business Relief is an exemption taking that asset out of the chargeable estate when calculating Inheritance Tax and is generally available on the transfer of shares in a private limited company – for more information on this, please consult an accountant or tax specialist).
Advantages of a Cross Option Agreement
The COA is effectively an agreement that does not create a legally binding obligation on either party to buy or sell the shares but simply gives both parties an option to buy or sell some time in the future. It is only the exercise of the option that creates a binding contract.Â
In order to ensure that the surviving party has sufficient funds to purchase the shares of the deceased party, it is best that both parties take out life insurance on the life of the other partner. This means that when one of the partners dies, the survivor will receive a payout under the Life Insurance policy which will provide the funds of money to purchase the deceased’s shares.
The COA can also make provisions as to how the value of the shares will be determined at the time the option to purchase the shares is exercised. This is more favourable than to make an estimate of the share value when drafting the COA.
Cross Option Agreements are legal documents that should be drafted by a Solicitor.
If you need a Cross Option Agreement, get in touch with our Commercial Department, and speak to one of our Solicitors who will be happy to help and advise.